3-1 Skyline College Chapter 3

3-2 The Accounting Equation ASSETS The property a business owns LIABILITIES The debts of the business OWNER’S EQUITY The owner’s financial interest in the business = +

3-3 Accounts help to: analyze, record, classify, summarize, and report financial information. Advantages of Accounts

3-4 Classification of Accounts Asset Accounts Asset accounts show the property a business owns. Liability Accounts Liability accounts show the debts of the business. Owner’s Equity Accounts Owner’s equity accounts show the owner’s financial interest in the business. Classification is a means of identifying each account: asset, liability, or owner’s equity.

3-5 =+ T Accounts ASSETS + Record Increases LEFT SIDE - Record Decreases RIGHT SIDE LIABILITIES - Record Decreases LEFT SIDE + Record Increases RIGHT SIDE OWNER’S EQUITY - Record Decreases LEFT SIDE + Record Increases RIGHT SIDE A T account is a type of diagram, used to analyze the effects of a business transaction.

3-6 Cash + Record Increases LEFT SIDE - Record Decreases RIGHT SIDE Assets appear on the left side of the accounting equation. Cash is an asset. Cash increases appear on the left side of the Cash T account. Decreases are shown on the right side. Asset Account

3-7 Liabilities & Capital Accounts Jason Taylor, Capital - Record Decreases LEFT SIDE + Record Increases RIGHT SIDE Owner’s equity appears on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity). Increases appear on the right side of the T account. Decreases appear on the left side. Capital is an owner’s equity account.

3-8 Effects of Business Transactions 1.Analyze the financial event. Use these steps to analyze the effects of the business transactions: 2.Apply the left-right rules for each account affected. 3.Make the entry in T-account form. Identify the accounts affected. Classify the accounts affected. Determine the amount of increase or decrease for each account.

3-9 Business Transaction Jason Taylor withdrew $90,000 from personal savings and deposited it in the new business checking account for JT’s Consulting Services. Analysis: (a) The asset account, Cash, is increased by $90,000. (a) The owner’s equity account, Jason Taylor, Capital, is increased by $90,000.

3-10 Left-Right Rules ASSETSOWNER’S EQUITY Record increases + Record increases + LEFTIncreases to asset accounts are recorded on the left side of the T account. RIGHTIncreases to owner’s equity accounts are recorded on the right side of the T account.

3-11 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

(a) 90,000 + (a) 90,000 CashJason Taylor, Capital T-Account Presentation

3-13 Business Transaction JT’s Consulting Services issued a $10,000 check to purchase a computer and other equipment. Analysis: (b) The asset account, Equipment, is increased by $10,000. (b) The asset account, Cash, is decreased by $10,000. Record a cash purchase of Equipment

3-14 Left-Right Rules ASSETS Record increases + Record decreases - ASSETS LEFTIncreases to asset accounts are recorded on the left side of the T account. RIGHTDecreases to asset accounts are recorded on the right side of the T account.

3-15 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-16 Equipment + (b) 10,000 Cash - (b) 10,000 T-Account Presentation

3-17 Reviewing the Effects of the Transactions The Cash account shows two transactions. The initial investment by the owner (a) The cash purchase of equipment (b) Equipment + (b) 10,000 Cash - (b) 10,000 + (a) 90,000

3-18 Liabilities are amounts a business owes its creditors. They appear on the right side of the accounting equation (Assets = Liabilities + Owner’s Equity). Liabilities Recall that when a purchase is made on account, a liability is created.

3-19 Business Transaction The firm bought office equipment for $12,000 on account from Office Plus. Analysis: (c) The asset account, Equipment, is increased by $12,000. (c) The liability account, Accounts Payable, is increased by $12,000. Recording a Credit Purchase of Equipment

3-20 Left-Right Rules ASSETS LIABILITY Record increases + Record increases + LEFTIncreases to asset accounts are recorded on the left side of the T account. RIGHTIncreases to liability accounts are recorded on the right side of the T account.

3-21 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-22 Equipment + (c) 12,000 Accounts Payable + (c) 12,000 T-Account Presentation

3-23 The Equipment account shows two transactions. The purchase of equipment for cash (b) The purchase of equipment on credit (c) + (b) 10,000 (c) 12,000 Reviewing the Effects of the Transactions EquipmentAccounts Payable + (c) 12,000

3-24 Business Transaction JT’s Consulting Services issued a check for $3,000 to Office Supplies Inc. to purchase office supplies. Analysis: (d) The asset account, Supplies, is increased by $3,000. (d) The asset account, Cash, is decreased by $3,000. Recording a Cash Purchase of Supplies

3-25 Left-Right Rules ASSETS Record increases + Record decreases - LEFTIncreases to asset accounts are recorded on the left side of the T account. RIGHTDecreases to asset accounts are recorded on the right side of the T account.

3-26 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-27 Supplies + (d) 3,000 Cash - (d) 3,000 T-Account Presentation

3-28 Reviewing the Effects of the Transactions The Cash account shows three transactions: The initial investment by the owner (a) The cash purchase of equipment (b) The cash purchase of supplies (d) Supplies + (d) 3,000 Cash - (b) 10,000 (d) 3,000 + (a) 90,000

3-29 Business Transaction JT’s Consulting Services issued a check in the amount of $5,000 to Office Plus. Analysis: (e) The asset account, Cash, is decreased by $5,000. (e) The liability account, Accounts Payable, is decreased by $5,000. Recording a Payment to a Creditor

3-30 Left-Right Rules LIABILITYASSETS Record decreases - Record decreases - LEFTDecreases to liability accounts are recorded on the left side of the T account. RIGHTDecreases to asset accounts are recorded on the right side of the T account.

3-31 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-32 Accounts Payable - (e) 5,000 Cash - (e) 5,000 T-Account Presentation

3-33 Reviewing the Effects of the Transactions + (a) 90,000 Cash (d) 10,000 (h) 3,000 (i) 5,000 + (b) 12,000 Accounts Payable - (e) 5,000 The Cash account shows four transactions: Initial investment (a) Equipment purchase (b) Supplies purchase (d) Payment on account (e) -

3-34 Reviewing the Effects of the Transactions + (a) 90,000 Cash (b) 10,000 (d) 3,000 (e) 5,000 + (c) 12,000 Accounts Payable - (e) 5,000 The Accounts Payable account shows two transactions: Credit purchase of equipment (c) Payment to creditor (e) -

3-35 Business Transactions JT’s Consulting Services issued a check for $7,000 to pay rent for the months of December and January. Analysis: (f) The asset account, Prepaid Rent, is increased by $7,000. (f) The asset account, Cash, is decreased by $7,000. Recording Prepaid Rent

3-36 Left-Right Rules ASSETS Record increases + Record decreases - LEFTIncreases to asset accounts are recorded on the left side of the T account. RIGHTDecreases to asset accounts are recorded on the right side of the T account.

3-37 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-38 Prepaid Rent + (f) 7,000 Cash - (f) 7,000 T-Account Presentation

3-39 Reviewing the Effects of the Transactions - (b) 10,000 (d) 3,000 (e) 5,000 (f) 7,000 + (a) 90,000 The Cash account shows five transactions: Initial investment (a) Equipment purchase (b) Supplies purchase (d) Payment on account (e) Advance rent payment (f) Prepaid Rent + (f) 7,000 Cash

3-40 An account balance is the difference between the amounts recorded on the two sides of an account. Account Balances

3-41 Calculating the Account Balance 1.Compute the totals of each side of the T account. 2.Subtract the smaller total from the larger total. The result is the account balance.

3-42 the total of those entries is the account balance. an account contains entries on only one side, that amount is the balance.an account shows only one amount, the balance is recorded on the left side.the total on the left side is larger, the balance is recorded on the right side.the total on the right side is larger than the total on the left side, Recording Account Balances IF THEN

3-43 Account Balance Cash + (a) 90,000 - (b) 10,000 (d) 3,000 (e) 5,000 (f) 7,000 Bal. 65,000 (90,000 – 25,000 = 65,000) 25,00090,000

3-44 Account balances for Carter Consulting Services ASSETS = LIABILITIES + OWNER’S EQUITY Cash Accounts Payable Jason Taylor, Capital (a) 90,000 (b) 10,000 (e) 5,000 (c) 12,000 (a) 90,000 (d) 3,000 (e) 5,000 Bal. 7,000 Bal 90,000 (f) 7,000 Bal. 65,000 Supplies SUMMARY OF ACCOUNT BALANCES (d) 3,000 ASSETS = LIABILITIES + OWNER’S EQUITY Bal 3,000 Prepaid Rent 65,000 7,000 90,000 3,000 (f) 7,000 7,000 Bal 7,000 22,000 Equipment 97,000 = 7, ,000 (b) 10,000 (c) 12,000 Bal. 22,000

3-45 Some owner’s equity accounts are classified as: Revenue Expense Separate accounts are used to record revenue and expense transactions. Revenue and Expense Accounts

Owner’s Equity Decrease Side Increase Side Revenue Decrease Side Increase Side Revenues increase owner’s equity. Increases in owner’s equity appear on the right side of the T account. Therefore, increases in revenue appear on the right side of revenue T accounts.

3-47 The right side of the revenue account shows increases and the left side shows decreases. Revenue Decrease Side - Increase Side + Decreases in revenue accounts are rare but might occur because of corrections or transfers.

During December the business earned $26,000 in revenue from clients who paid cash for bookkeeping, accounting, and consulting services. JT’s Consulting Services 3-48

3-49 JT’s Consulting Services Which account is debited? For what amount? Which account is credited? For what amount?

Reviewing the Effects of the Transactions Cash + Bal. 65,000 (g) 26,000 Fees Income + (g) 26,000 $26,000 (g) is entered on the left (increase) side of the asset account Cash. $26,000 (g) is entered on the right side of the Fees Income account. 3-50

3-51 Accounts Receivable The accounts receivable account is used for charge customers. Accounts receivable is classified as an asset.

3-52 Business Transaction In December JT’s Consulting Services earned $9,000 from various charge accounts clients. Analysis: (h) The asset account, Accounts Receivable, is increased by $9,000. (h) The revenue account, Fees Income, is increased by $9,000. Record Revenue from Services Sold on Credit

3-53 Left-Right Rules ASSETS REVENUE Record increases + Record increases +

3-54 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-55 T-Account Presentation Accounts Receivable + (h) 9,000 Fees Income + (h) 9,000

3-56 Accounts Receivable + (h) 9,000 Fees Income + (g) 26,000 Reviewing the Effects of the Transactions REVENUE ACCOUNTS + Record increases REMEMBER - Record decreases (h) 9,000

3-57 Analysis: (i) The asset account, Cash, is increased by $4,000. (i) The asset account, Accounts Receivable, is decreased by $4,000. Business Transaction Charge account clients paid $4,000, reducing the amount owed to JT’s Consulting Services. Recording Collections from Accounts Receivable

3-58 Left-Right Rules ASSETS Record increases + Record decreases -

3-59 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-60 T-Account Presentation Cash + (i) 4,000 Accounts Receivable - (i) 4,000

3-61 Remember: The revenue was recorded when the sales on credit were recorded... not... when cash is collected. Cash Bal. 65,000 (g) 26,000 Accounts Receivable - (i) 4,000 + (h) 9,000 Reviewing the Effects of the Transactions (i) 4,000

3-62 Expenses decrease owner’s equity. Owner’s Equity Decrease Side Increase Side Revenue Decrease Side Increase Side Expense Increase Side Decrease Side Decreases in owner’s equity appear on the left side of the T accounts.

3-63 Business Transaction In December JT’s Consulting Services paid $7,000 in salaries. Analysis: (j) The asset account, Cash, is decreased by $7,000. (j) The expense account, Salaries Expense, is increased by $7,000. Recording an Expense for Salaries

3-64 Left-Right Rules EXPENSE Record increases + ASSETS Record decreases -

3-65 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-66 Salaries Expense + (j) 7,000 Cash - (j) 7,000 T-Account Presentation

Bal. 65,000 (g) 26,000 (h) 4,000 Salaries Expense + (j) 7,000 Cash - (j) 7,000 EXPENSE ACCOUNTS - Record decreases REMEMBER + Record increases Reviewing the Effects of the Transactions

3-68 Business Transaction JT’s Consulting Services issued a check for $500 to pay the utilities bill. Analysis: (k) The asset account, Cash, is decreased by $500. (k) The expense account, Utilities Expense, is increased by $500. Recording an Expense for Utilities

3-69 Left-Right Rules EXPENSE Record increases + ASSETS Record decreases -

3-70 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-71 T-Account Presentation Utilities Expense + (k) 500 Cash - (k) 500

3-72 Utilities Expense + (k) 500 Cash - (j) 7,000 + Bal. 65,000 (g) 26,000 (h) 4,000 (k) 500 Reviewing the Effects of the Transactions

3-73 A drawing account is a temporary owner’s equity account set up to keep track of the owner’s withdrawals from the business during the period. The Drawing Account

3-74 Drawing decreases owner’s equity. Owner’s Equity Decrease Side - Increase Side + Revenue Decrease Side Increase Side Expense Increase Side Decrease Side Drawing Increase Side + Decrease Side - Decreases in owner’s equity appear on the left side of the T accounts.

3-75 Jason Taylor wrote a check to withdraw $4,000 cash for personal use. Analysis: (l) The asset account, Cash, is decreased by $4,000. (l) The owner’s equity account, Jason Taylor, Drawing, is increased by $4,000. Business Transaction The Drawing Account

3-76 Left-Right Rules DRAWING ACCOUNT Record increases + Record decreases - ASSETS

3-77 T-Account Presentation For what amount? Which T account has an entry on the left? Which T account has an entry on the right?

3-78 T-Account Presentation Jason Taylor, Drawing + (l) 4,000 Cash - (l) 4,000

3-79 (j)7,000 (k) Bal. 65,000 (g) 26,000 (i) 4,000 Jason Taylor, Drawing + (l) 4,000 Cash (l) 4,000 Reviewing the Effects of the Transactions -

3-80 Any Account Left Side DEBIT Right Side CREDIT DEBIT SIDE CREDIT SIDE Accountants refer to the left side of an account as the debit side instead of saying the left side. The right side of the account is called the credit side. The Rules of Debit and Credit

3-81 A double-entry system is an accounting system that involves recording the effects of each transaction as debits and credits. Double-Entry System Debit Credit Every transaction must have at least two parts:

3-82 Debit Credit + - Increase Decrease Side Side (Normal Bal.) Debit Credit - + Decrease Increase Side Side ( Normal Bal.) Debit Credit - + Decrease Increase Side Side ( Normal Bal.) Debit Credit + - Increase Decrease Side Side (Normal Bal.) Debit Credit - + Decrease Increase Side Side (Normal Bal.) Debit Credit + - Increase Decrease Side Side (Normal Bal.) Rules for Debits and Credits Asset Accounts Liability Accounts Owner’s Capital Account Owner’s Drawing AccountRevenue Accounts Expense Accounts

3-83 A trial balance is a statement to test the accuracy of total debits and credits after transactions have been recorded. Debit balances = Credit Balances The Trial Balance

Enter the trial balance heading showing the company name, report title, and closing date for the accounting period. 2. List the account names in the same order as they appear on the Chart of Accounts (financial statements). Assets Liabilities Owner’s Equity Revenue Expenses Complete the trial balance in six steps.

Enter the ending balance of each account in the appropriate Debit or Credit column. 4. Total the Debit column. 5. Total the Credit column. 6. Compare the total debits with the total credits. Complete the trial balance in six steps.

3-86 DEBITCREDIT ACCOUNT NAME Cash Accounts Receivable Supplies Prepaid Rent Equipment Jason Taylor, Capital Accounts Payable Jason Taylor, Drawing Fees Income Salaries Expense Utilities Expense Totals 132,000 83,500 7,000 90,000 4,000 35,000 7, ,000 7,000 5,000 3,000 JT’s Consulting Services Trial Balance December 31, 2007

3-87 Adding trial balance columns incorrectly Recording only half a transaction – for example, recording a debit but not recording a credit, or vice versa Recording both halves of a transaction as debits or credits rather than recording one debit and one credit Recording an amount incorrectly from a transaction Recording a debit for one amount and a credit for a different amount Making an error when calculating the account balances Some common errors in a trial balance are:

3-88 DEBITCREDIT ACCOUNT NAME Cash Accounts Receivable Supplies Prepaid Rent Equipment Jason Taylor, Capital Accounts Payable Jason Taylor, Drawing Fees Income Salaries Expense Utilities Expense Totals 132, ,000 83,500 7,000 90,000 4,000 35,000 7, ,000 7,000 5,000 3,000 JT’s Consulting Services Trial Balance December 31, Check the arithmetic. Finding Trial Balance Errors

3-89 DEBITCREDIT ACCOUNT NAME Cash Accounts Receivable Supplies Prepaid Rent Equipment Linda Carter, Capital Accounts Payable Linda Carter, Drawing Fees Income Salaries Expense Utilities Expense Totals 122, ,000 73,500 7,000 90,000 4,000 35,000 7, ,000 7,000 5,000 3,000 JT’s Consulting Services Trial Balance December 31, ,400 ACCOUNT ____________________________ ACCOUNT NO. ________ DATE DESCRIPTION POST REF. DEBITCREDITDEBITCREDIT BALANCE Nov. 30 Dec Bal. forward J2 21,000 3,000 5, ,000 49,000 70,000 73,000 68,000 67,400 83,500 Cash Check that the correct account balances were transferred to the correct trial balance columns.

3-90 After the trial balance is prepared, the financial statements are prepared. Net income from the income statement is used on the statement of owner’s equity. The ending balance of the Jason Taylor, Capital account, computed on the statement of owner’s equity, is used on the balance sheet. Financial Statements

3-91 JT’s CONSULTING SERVICES Balance Sheet December 31, 2007 ASSETS LIABILITIES Cash 83, Accounts Payable 7, Accounts Receivable 5, Supplies 3, Prepaid Rent 7, OWNER’S EQUITY Equipment 22, Jason Taylor, Capital 113, Total Assets 120, Total Liabilities and Owner’s Equity 120, JT’s CONSULTING SERVICES Statement Of Owner’s Equity Month Ended December 31, 2007 Jason Taylor, Capital, Dec. 1, , Net Income for December 27, Less Withdrawals for December 4, Increase in Capital 23, Jason Taylor, Capital, Dec. 31, , JT’s CONSULTING SERVICES Income Statement Month Ended December 31, 2007 Revenue Fees Income 35, Expenses Salaries Expense7, Utilities Expense Total Expenses 7, Net Income 27,500.00

3-92 A chart of accounts is a list of the accounts used by a business to record its financial transactions. Chart of Accounts Each account has a number and a name. The account number is assigned based on the type of account. The balance sheet accounts are listed first, followed by the income statement accounts.

3-93 Balance Sheet Accounts ASSETS 101 Cash 111 Accounts Receivable 121 Supplies 137 Prepaid Rent 141 Equipment LIABILITIES 202 Accounts Payable OWNER’S EQUITY 301 Jason Taylor, Capital Statement of Owner’s Equity Account 302 Jason Taylor, Drawing Income Statement Accounts REVENUE 401 Fees Income EXPENSES 511 Salaries Expense 514 Utilities Expense JT’s CONSULTING SERVICES Chart of Accounts Account Number Account Name

3-94 Permanent accounts are: Assets Liabilities Owner’s capital The permanent accounts appear on the balance sheet at the end of an accounting period. The balances of these accounts are then carried forward to start the new accounting period. Permanent Accounts

3-95 A temporary account is an account whose balance is transferred to another account at the end of an accounting period. Temporary Accounts Temporary accounts are: Drawing Revenue Expenses